Returns At Chennai Petroleum (NSE:CHENNPETRO) Appear To Be Weighed Down

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Chennai Petroleum (NSE:CHENNPETRO), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

Return On Capital Employed (ROCE): What is it?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Chennai Petroleum, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.25 = ₹12b ÷ (₹142b - ₹94b) (Based on the trailing twelve months to June 2021).

So, Chennai Petroleum has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Oil and Gas industry average of 13%.

View our latest analysis for Chennai Petroleum

Historical performance is a great place to start when researching a stock so above you can see the gauge for Chennai Petroleum's ROCE against it's prior returns. If you'd like to look at how Chennai Petroleum has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Chennai Petroleum's ROCE Trend?

Over the past five years, Chennai Petroleum's ROCE and capital employed have both remained mostly flat. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. Although current returns are high, we'd need more evidence of underlying growth for it to look like a multi-bagger going forward.

On a side note, Chennai Petroleum's current liabilities are still rather high at 66% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

Although is allocating it's capital efficiently to generate impressive returns, it isn't compounding its base of capital, which is what we'd see from a multi-bagger. Since the stock has declined 48% over the last five years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think Chennai Petroleum has the makings of a multi-bagger.

If you want to know some of the risks facing Chennai Petroleum we've found 2 warning signs (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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